Tuesday, December 11, 2007

Kudlow 101: Foreclosures & The Fed

The Fed is linked to foreclosures, and they can do something about it.

Take a look at the following homeowner distribution chart. It shows where all the mortgages are. It may surprise you to see who’s holding what kind of paper. (Hat tip to University of Michigan Professor Mark Perry and his fabulous blogsite, Carpe Diem. He put this together using Mortgage Bankers Association data.)

So, who’s got the mortgages?

Well, Prime Fixed comprises 41 percent. That’s the biggest share. Next up is Americans with no mortgages at all; they’re at 35 percent. And so on down the list. But I’d like to draw particular attention toward the bottom of the list, to the Subprime ARM group. They’ve got a 4.4 percent share. That’s obviously a very small percentage.

This next chart (also courtesy of Carpe Diem) shows you where the foreclosure problem resides. The following point is key: the smallest is the largest. In other words, the Subprime ARM is where the bulk of the foreclosures are.

In fact, the Subprime ARM group is responsible for 43 percent of foreclosures. But that group is a very small percentage of total mortgage holders. Moreover, the next group on the foreclosure list is the Prime ARM. They’ve got an 18.7 percent share. Add them together and over 60 percent of foreclosures are ARM related. In other words, it’s the skyrocketing of adjustable rates over the past couple years that’s the problem.

That’s the key point. It’s the adjustable rates—affected by the Fed—that’s caused the problem.

Okay, last chart. This shows the relationship between the fed funds rate and the subprime foreclosures. This is absolutely incredible.

You will notice that they are moving together. In fact, they start moving together in ’04. So there is a clear link between tight money from the Fed and the foreclosure rate.

The point of all this is to suggest that the Federal Reserve bears some of the blame for the huge increase in these adjustable rates. Frankly, very few people (and almost no economists) predicted rates would rise from 1 percent to 5.25 percent. So if the Fed truly wants to help people, they should get that funds rate down, so the pressure will come off adjustables.

About Me

Larry Kudlow

Lawrence Kudlow is CNBC’s Senior Contributor. For many years, he was the host of CNBC’s “The Kudlow Report”. He is also the host of The Larry Kudlow Show, which broadcasts on Saturdays from 10am to 1pm ET on WABC Radio and is syndicated nationally by Cumulus Media. He is also a nationally syndicated columnist and a former Reagan economic advisor. CNBC's The Kudlow Report also airs on Sirius (ch.129) and XM (ch.127) weeknights at 7pm ET.